BREAKINGVIEWS-Oracle will test AI’s scale-begets-scale trade

By Robert Cyran

NEW YORK, Sept 10 (Reuters Breakingviews) - Long-standing corporate titans aren’t supposed to add over $200 billion to their market value in a single day. Yet 48-year-old Oracle ORCL.N has done just that. While today’s results, revealed in quarterly earnings released Wednesday, are run-of-the-mill, the company’s near future is wildly exciting, its revenue backlog more than tripling to $455 billion. Investors assuming that investments needed to satisfy this demand will generate attractive and sustainable returns are counting AI chickens before they hatch.

Oracle’s market value, now approaching $1 trillion, is all about tomorrow. Annual sales growth of 12% disappointed, while earnings per share declined. Yet the company projected that cloud infrastructure revenue of $18 billion this fiscal year will climb to an astonishing $144 billion over the following four years.

That’s thanks to seemingly insatiable demand from the likes of OpenAI and Meta Platforms META.O. Serving their needs, however, requires a lot of investment. Already-heavy capital expenditure jumped well above expectations, more than tripling in the quarter to $8.5 billion. Oracle will spend some $35 billion this fiscal year. While analysts foresee the return on all this invested capital falling by about a third compared to historic levels, that would leave it at roughly 20%, attractive at such gigantic scale.

Co-founder Larry Ellison has key advantages. Oracle’s business stitching together various cloud services has drawn Amazon.com AMZN.O, Alphabet-owned Google GOOGL.O and Microsoft MSFT.O. Revenue from these firms rose over 1,500% in the quarter. Most big companies already run on Oracle databases, making it easier to combine gear and software. This unit also doesn’t require as many resources as land-hungry new-build data centers.

Yet lashing its fate to Amazon or Google may leave Oracle at the whims of giants using it as a temporary expedient to control their own ramped-up investment spending. It is taking greater risk than its customers: Oracle is burning cash, while Microsoft is predicted to have $75 billion of free cash flow this calendar year, according to LSEG data.

Nonetheless, in the always-tomorrow, never-today world of AI, all this spending is simply taken as a guarantor of incoming business. On Thursday morning, Oracle shares leaped over 30%. They were already trading at 34 times estimated earnings over the next year, more than doubling their ten-year average.

None of this accounts for the danger that the revenue backlog shrinks if AI buildout efforts diminish or fail. Massive investment across the sector could put pressure on pricing, and the vast inventory of equipment that the company holds includes bleeding-edge tech that typically depreciate at warp speed. Continuing to wring chunky returns out of such a massively expanded capital base is a challenge entirely unlike Big Tech’s software-oriented past. Their investors, though, are using the same trust-the-plan playbook they always have.

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CONTEXT NEWS

Shares of Oracle opened up 32% at the beginning of trading on September 10, adding over $200 billion to the technology company’s market capitalization following quarterly results released the previous day.

Oracle reported revenue for the quarter ending August 31 of $14.9 billion, an increase of 12% from the same period last year. Earnings per share fell 2%, to $1.01 a share.

However, the company’s remaining performance obligations, a measure of its revenue backlog, rose 359% to $455 billion. Oracle said it now foresees cloud infrastructure revenue climbing from $18 billion this fiscal year to $144 billion over the following four years.

Oracle’s capital expenditure for the quarter was $8.5 billion, compared to $2.3 billion in the same period last year.